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Rocky times for startups: Mutual funds devalue and VCs turn off money hose

Everyone's waiting for the crash

Silicon Valley startups are facing a tough quarter as funders wait to see if a tech crash is on its way.

Tech stocks have taken a battering this year, doing far worse than the overall market, and there have been numerous signs that the ludicrous over-valuations of tech companies – especially the so-called "unicorns" – are coming under proper scrutiny.

However, nothing says crunch like the money drying up. And according to several reports, that is exactly what's happening.

CB Insights closely follows the tech startup market and has reported a significant slowdown in investment, with a drop of 30 per cent for the last quarter of 2015. Although its Q1 data won't be available until the end of this month, the company has already posted a number of blog posts highlighting its view that the crunch is coming – or may already be here.

In its most recent post, in which it asks "When Will We Know if the Bubble Has Actually Popped?", CB Insights notes that 60 per cent of the "unicorns" will need to raise more capital in the next three quarters, and 40 per cent of them in the first two quarters.

At the same time as the startups' need for funds grows more desperate, valuations for those companies have been going down.

Even in a market that has largely avoided going public and has instead relied on the even more bubble-led VC self-evaluations, the money men have started admitting that the party may be over.

Sell! Fast!

There has been a sudden slew of startup sell-offs to larger companies as they realize the opportunity to cash out is rapidly disappearing. Pandora bought music streaming service Rdio, Uber wannabe SideCar sold to General Motors, and so on.

But what is more troubling is that relatively large startups have started shutting up shop altogether when new funding has failed to materialize. BuzzFeed wannabe Pixable has shut down – leading of course to a blog post on Medium.

Bitcoin startup Bonafide has also died. Likewise food delivery company Dine In (no shortage of these companies). And news aggregator Prismatic. There are of course always startups going to the wall, but this time the companies are a little bigger and seemingly more stable than the usual crop.

Bloomberg spoke to a number of VCs who all said they were sitting on their money right now until the market stabilizes.

Mike Volpi of Index Ventures said, for example, "when you don't know what something's worth, you don't know whether you are getting a good deal or a bad deal, so the obvious thing to do is, not much."

Although VCs have been awarding themselves great deals for a few years in preferential stock, so a company only has to be worth more in total than they put in for them to come out with a profit, the sudden reduction in valuations has given room for pause.

Square was one of the few tech IPOs in recent years and it had to cut its opening price not once but twice – from $6bn to $4.2bn to $2.9bn – before it went onto the public market.

Likewise the valuation of Snapchat and Delphix in funding rounds – down 25 and 40 per cent respectively. Thumbtack's recent funding valued it 40 per cent lower. Jet.com is down 47 per cent.

Eye of the shareholder

The big boys have noticed. Mutual funds have been sharply cutting their valuation of startup investments and stopped putting money into new ones. According to one analysis by the Wall Street Journal, those devaluations are averaging 28 per cent. And those are, of course, optimistic best guesses because no one wants to devalue their own stock below its market price.

The irony is that as more institutionalized investors try to get a handle on just how much their assets are worth, they are starting to provide data into what has always been an opaque market.

And as with the Wizard of Oz, the more you learn about the inner workings, the less impressive it all appears.

No one has truly believed in the countless billion-dollar valuations of so many tech companies that have yet to make a profit or show a solid customer base for some time. Well, except Marc Andreessen.

But the bluster of Silicon Valley, combined with the fact that no one loses and everyone gains with ever-increasing valuations, has meant that it has been buoyed up with confidence.

As soon as that confidence starts waning, reality dawns, and funds and startups burning through money in the hope of being the next breakout success will start to dry up. So far, all the indications are that we are heading square into a tech market crunch. ®

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